VolatilityAnalytics.com

You really can’t ask for much more in VXX. So often the VIX futures sit in a range where they are untradeable, usually when the VIX is in the 14-16 area. In those cases, getting long volatility could eat you alive, yet getting short could get you killed. This is not one of those times.

Let’s start with a chart of the front month VIX future this year:

There is a flow to these spikes, no? Granted this is only 2014 right here. But go back to last year and the year before that and you will find that this rhythm persisted then too. I don’t ever look at volatility like folks out there on CNBC and stocktwits, trying to get ready for the next crash, that is wasting precious time and money when you can take what the VIX gives you over and over again. Sure, if there is a crash, I’ll be happy to ride that too, but realistically, we deal with the market we have, not the one that we may want.

So every 3-6 weeks, you get some sort of rumble, and this is normal and healthy in bull markets. And now that the “sell in May” headlines are fading, it is time to look toward the next rumble. People are feeling better, their tech stocks have stopped cratering, and May is off to a quiet start. Let’s look at how last May went, just for fun:

May 3rd featured a better than expected jobs number, and off it went. The last green bar was on options expiration last May and then things got wild. There are correlations to volatility and the option expiration cycle, and there are correlations to volatility and seasonality. I will go into these frequently in the newsletter.

Today I added a few VXX May 30th $38 calls for 2.35. Tomorrow is the day that I was targeting to add more considering the performance of Tuesday in the markets this year. It has been an automatic ramp on Tuesdays, so it may offer some nice prices to get long vol.

(I will be starting a volatility forecasting and signal service shortly for $25/mo if you are interested, and that will also include an email service with real-time trades, and a weekly newsletter breaking down the volatility landscape. There will also be sections with basic option trades and education, ETF analysis for straight trades on volatility, inverse and leveraged funds, and profit loss diagrams. Imagine what you see here and a lot more. Email me at scottmurray1 (at) gmail.com if you are interested.)

In part one, we looked at the ranges of different sector VIXs, compared the S&P VIX to a similar past time-frame during a mid-term election cycle, examined the current VIX futures contango structure, and did some rough calculations of negative roll yield in the current structure. Now we want to examine some trade set-ups to take advantage of a low volatility environment.

I want to demonstrate three trade scenarios:

-Put spread sales on VXX and UVXY

-Long VXX calls

-Long VXX diagonal spreads

The main premise of these set-ups is two-fold: A. That volatility can go higher in the next month or two due to seasonal factors, and because volatility is at the low end of the range, thus risk is under-priced. B. That these trades can be set up with an asymmetric risk/reward scenario; that the risk of loss is far less than the potential for gain.

Let’s make a projection of VXX option prices using the negative roll formula:

So if you believe the VIX structure will remain in this format, here are some projections for VXX and UVXY prices at future points in time taking into account the negative roll yield. In 5 trading days the VXX will be roughly 39.52, in 10 days 39.03, etc. The UVXY decays twice as fast, relative to its current price.

VXX Put Spreads:

Here is the VXX option chain:

One put spread example would be to sell VXX put spreads for next week or the week after at a level that would take into account the negative roll, and gives you some wiggle room for a shift down in the VIX futures of 1 or 2 percent more. For the May 23rd expiration (May5), the VXX 38-37 put spread can be sold for roughly a .25 credit, whereas 15 days of negative roll only get you to $38.55. If the futures curve fell around 2%, that would equate to a VXX price of roughly the $38.55 less another 2% or 37.75.

Thus, it would take not only a significant drop in vol from here for this trade to lose , but there could be no hiccup in the market during this period. If the S&P saw any selling, the VXX simply cannot get to this price. The odds are that you will keep the premium. This same method can be applied to UVXY, at say the $50-48 levels.

VXX Calls:

In the above case, your profit is capped at .25, but it you are bullish on volatility or bearish on the market, it is not a bad time to get long vol using VXX calls. As we described above, there is only so far for the VXX to fall considering how low the futures are, so you can choose some calls that don’t put the entire cost of the calls at risk yet give you a ton of upside if the market sees increasing volatility or sells off:

Again, knowing that the VXX will have a tough time falling below $38 in 20 trading days, you could purchase the May 30th VXX $37 calls for $3.35 debit. At risk over the next two weeks is realistically around $1.50 of that $3.35, but if the market sells off between now and May 30, the upside could be 100-300% of your real risk of only $1.50 per contract. It would be up to you in two weeks to reevaluate how you see the next two weeks after that playing out, and adjust accordingly, if you hadn’t sold them by that point.

VXX Diagonal Spreads:

This is about as beautiful as option trades get, because you not only take advantage of rapidly decaying premium out-of-the-money, but use that to defray some of the cost of a long volatility position:

If you suppose that this week will be a quiet one, but there are storm clouds on the horizon, you could sell the May 9th $41 call for .45  or the $41.5 call for .35 and buy the May 23rd $38 call for around $2.50. Now you are long volatility for no premium paid, essentially $2 which is the current VXX price, less the strike price of the long call, $38. Another advantage of this trade is that you can sell against it again at the end of this week to further cut into your cost of the long call. Also, if volatility rises between now and Friday, diagonal spreads benefit by rising volatility or vega.

So there are three ways to get long vol without paying high premium in VXX or VIX calls. The odds are with you on these trades, whereas buying out-of-the-money calls on the VIX and VXX as many people do is a consistent losing strategy.

I will be starting a volatility forecasting and signal service shortly for $25/mo if you are interested, and that will also include an email service with real-time trades, and a weekly newsletter breaking down the volatility landscape. There will also be sections with basic option trades and education, ETF analysis for straight trades on volatility, inverse and leveraged funds, and profit loss diagrams. Imagine what you see here and a lot more. Email me at scottmurray1 (at) gmail.com if you are interested.

This has been an interesting year in volatility. The past few years have rewarded the most simple of vol strategies, selling vol into U.S. political events and over-hyped European debt crises. (See Cyprus, Portugal, Greece. Greece just came to the bond market last week, and it was SEVEN times oversubscribed at a yield of 4.95%. Apparently their “junk” rating is junk: http://www.bloomberg.com/news/2014-04-22/samaras-sees-greek-bond-yields-falling-more.html)

But now, just as then, a simple strategy can be almost as profitable as long as you exercise patience and know your math in the volatility ETN’s.

Volatility that remains in a firm low range for long periods is not rare, although folks on television frequently harp about the VIX being broken. But let’s be frank, a lot of the CNBC folks do almost zero homework and regurgitate what they hear among each other as fact. The Russell 2k VIX (RVX) and the Nasdaq VIX (VXN) both exceeded 20 recently, a fact you would never hear on CNBC. That is where the volatility was, and the implied volatilities of those indexes reflected that risk.

Russell 2k, Nasdaq 100, and S&P 500 VIXs:

Unfortunately for vol traders/hedgers, Nasdaq VIX and Russell 2000 VIX options were a flop. That also appears to be the case with the VXST, the short-term S&P 500 VIX options. There has yet to be any significant volume in that recently released product. Fact is there are plenty of weekly options available these days in the ETF world for hedging/trading. But, the CBOE does a terrible job of educating anyone in the media about how the VIX works, and therefore no interest or knowledge flows into what could be very useful option products in the VXN and RVX. Especially this year, as you can see in the above charts that the Nasdaq and Russell indexes have entered higher vol ranges.

Anyway, back to plain old S&P VIX, let’s look at a period of time when the VIX held a similar tight range below 18:

Jan 2004 to June 2006:

And 2012 to today:

These are weekly VIX charts covering the same length of time. Not only that, these two charts cover the same time in the presidential cycle, ending in the mid-term election year. They are incredibly similar. In 2004-6, the internet bubble was fading into the distance, and here we are trying to forget about the mortgage crisis.

So vol never goes away, but it hibernates for weeks just to reappear again, albeit in a lower range. So if you have weeks of VIX in the 12-14 range, what can you do? Sell VXX and UVXY put spreads.

First you need to calculate the negative roll in the futures term structure. Here at vixcentral.com, he does it for you:

Courtesy vixcentral.com

So in the VXX’s case, the calculation is roughly:

.0638 (contango given in the above chart) / 25 (days in this vix roll cycle) x $40 (VXX price) = 10 cents per day of negative roll. This is what the VXX loses on a daily basis at this current structure while rolling from May to June on a daily basis. Now you know what you can roughly expect the VXX to lose over time provided this structure persists. It allows you to project how far the VXX could fall.

Now you need to know how much the VXX is holding of each future, May and June:

Almost 50% of each. This is important because the more expensive June future will not rise or fall as fast as the front month. So, if the VXX is heavily back-loaded or front-loaded with a majority of one option, it is far more susceptible to big moves up or down. So right now, it is sort of sluggish, it does not want to move at the same speed as spot VIX. You need to know this, because generally this product moves quickest at the beginning and end of VIX cycles.

Ok, we’ve laid the groundwork for the trades. Next post this weekend I will show some option chains and build some trade structures.

With the market finally showing some weakness after an unrelenting move higher over the last six weeks, the VIX has come off the 13 handle to almost 18. None of this is out of the ordinary, although the financial media acts like the world is falling every time the market takes any kind of a break. There always must be an explanation for a down day, and if they didn’t have Crimea or China to fall back on, they would find some rumor or bring out the bearish punditry to babble about fiat currencies or 1929 chart similarities. There is more BS and misinformation on CNBC than anywhere else unless you watch Fox News.

These pullbacks are opportunities to sell some vol, and there are plenty of ways to do that. First, the VIX curve provided buy vixcentral.com:

You can see the backwardation in the front of the curve and how the entire curve shifted higher over the past week. The VIX March future expires next week, so it will be in lockstep with the VIX at this point. The implied vol on the VIX options expiring Tuesday is through the roof:

If you think things will not escalate in the next two days, or that there was a risk premium in the Crimean vote, then you can sell VIX call spreads that expire Tuesday and settle Wednesday morning. 19-21 would net around .25, and 18-20 would net around .50.

Another way to sell vol without having to look at you computer every 5 seconds, would be to sell VXX spreads out to March 28th or later. It is holding virtually all April futures right now, and that will be the front month come Wednesday morning. Here is the chain for March 28th, which is a bit off due to the weekend quoting being less than accurate:

The 48-49 spread can be sold for about .30, and you have two weeks for things to calm down only slightly. If the market sells off to 1800 or below, than you can expect the VIX to approach 20 and the VXX can certainly rise 10-15%, sending the VXX to the 52 area. But even that will not last for very long as the faster the market falls, the faster it gets to real support. (Permabears can ignore that sentence, since we all know you think the SPX is going to 1000.) The key will be to roll this spread out before it’s too late and it widens. But if the VXX were to head to 52, I would be selling April 4 or 11 spreads over 55.

Other options of selling vol include selling put spreads on the ETF’s with elevated vol like IWM, FAS and TNA. You can get almost .50 for an 86/84 Mar 28th FAS put spread. You can also sell SPY put diagonals, taking advantage of heightened vol in the nearer options.

On April 10th, the VXST, or short-term 9-day rolling VIX based on SPX option volatility will give vol traders the ability to trade short term vol in an more efficient way than trading the monthly VIX options. I will discuss that more as we get closer to that date.

This will be the trade that makes your Christmas a nice one, and it is very basic. I will have more to say about this next week, but suffice it to say, I will be shorting the UVXY soon, and I will never cover the position, essentially evading capital gains tax. More to come. Meanwhile, the VIX curve has flattened out in a way that has been rare this year:

Courtesy: vixcentral.com

The VIX finally came alive, as the market really cascaded through obvious support levels on heavy volume. This is still not the time to sell vol unless you are very nimble. There will be plenty of time to sell it after the event risk ends and the volatility exhale commences.

I warned readers to be wary of selling vol recently, and those that ignored that are feeling some pain. Patience is key in finding the entry point. If you have to be early, save some selling power for a real scare. We may have two weeks to go before the optimal entry point presents itself.

Stay tuned. These are the opportunities you wait months for.